An awful auction. A decent result.
By David Enna, Tipswatch.com
Back on October 22, 2020, a new 5-year Treasury Inflation-Protected Security — CUSIP 91282CAQ4 — auctioned with a depressingly low real yield to maturity of -1.320%, which at the time was the second-lowest real yield ever recorded for a 5-year TIPS at auction.
Think back: Just five years ago, investors were willing to accept a real yield that was guaranteed to under-perform inflation by 1.320% for five years. Seems mind-boggling today. But that was the investment reality in 2020, as the Federal Reserve ramped up bond-buying quantitative easing at the height of the COVID-19 pandemic. At one point, the Fed held more than one-fifth of total TIPS outstanding.
It is therefore amazing that this TIPS ended up being a decent investment, especially if you compare it to a nominal 5-year Treasury note at the time, which was yielding an insanely low 0.37%. That created an inflation breakeven rate of 1.69%. (At the time U.S. inflation was running at 1.2%.)
In my preview article for this auction, I noted the seriously ugly real yield still offered appeal versus the nominal Treasury:
In the current environment of ultra-low interest rates for safe investments, this TIPS should be considered “above average.” Why? Because it provides a hedge against unexpected future inflation. The Federal Reserve has openly committed to forcing annual U.S. inflation higher than 2% a year, for an extended period of time, as long as the labor market remains weak.
I also pointed out that the Series I Savings Bond was a much better investment with a fixed rate of 0.0%, more than 120 basis points higher than the 5-year TIPS:
I Bonds are better than TIPS, across the entire maturity spectrum.
How did this TIPS do?
As it turned out, inflation over the last 5 years averaged 4.5%, well above the auction’s inflation breakeven rate of 1.69%. So CUSIP 91282CAQ4 outperformed the nominal 5-year Treasury by a whopping 2.81% a year. It ended up producing a nominal return of 3.117%, versus the 5-year Treasury note’s 0.37%.
This result continues a five-year string of out-performance of TIPS over nominal Treasurys, thanks to the 40-year-high surge in inflation that peaked in June 2022 at 9.1%. Inflation continues today at 2.9%, well above the expectation of 1.69% in October 2020.
I Bond was the winner
Obviously, an I Bond with a 0.0% fixed rate (which is equivalent to its real yield) is going to out-perform a TIPS with a negative real yield. If you purchased an I Bond in October 2020 with a fixed rate of 0.0%, it will have created a nominal yield of 4.03% through April 2026, about 91 basis points better than the TIPS (Source: Eyebonds.info).
And bond funds?
Vanguard’s Total Bond Fund ETF (BND) has had a total annual return of -0.33% over the last five years, according to Morningstar. That poor performance was caused by the beating it took in 2022, when its annual return was -13.1%.
Vanguard’s Short-Term TIPS ETF (VTIP) has had a total annual return of 3.71% over the last 5 years, a bit better than CUSIP 91282CAQ4’s performance. It benefits from a shorter duration and counter-acting gains from higher inflation.
The iShares TIPS ETF (TIP), which holds the full range of maturities, has had a total annual return of 1.32% over the last five years, under-performing CUSIP 91282CAQ4.
Moral of the story
Two very important takeaways: 1) An I Bond with a fixed rate of 0.0% will be a very attractive investment any time the Federal Reserve decides to repress interest rates through quantitative easing. (Let’s hope we don’t see that again.) And 2) Even a TIPS with a negative real yield can be “relatively” attractive if the inflation breakeven rate is lower than seems likely.
Notes and qualifications
My TIPS vs. Nominals chart is an estimate of performance.
Keep in mind that interest on a nominal Treasury and the TIPS coupon rate is paid out as current-year income and not reinvested. So in the case of a nominal Treasury, the interest earned could be reinvested elsewhere, which would potentially boost the gain. For certain, we don’t know what the investor could have earned precisely on an investment after re-investments.
In the case of a TIPS, the inflation adjustment compounds over time, and that will give TIPS a slight boost in return that isn’t reflected in the “average inflation” numbers presented in the chart.
• Confused by TIPS? Read my Q&A on TIPS
• TIPS in depth: Understand the language
• TIPS on the secondary market: Things to consider
• TIPS investor: Don’t over-think the threat of deflation
• Upcoming schedule of TIPS auctions
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David Enna is a financial journalist, not a financial adviser. He is not selling or profiting from any investment discussed. I Bonds and TIPS are not “get rich” investments; they are best used for capital preservation and inflation protection. They can be purchased through the Treasury or other providers without fees, commissions or carrying charges. Please do your own research before investing.
Treasury Inflation-Protected Securities 
Thanks for the detailed analysis. I always had this confusion: what’s good of the bond ETF, especially the tips ETF? It seems that they comes with great risk that is related to the feds’ rate decision but we can’t recover the money by waiting for it to mature… While it seems that the bond ETF such as ETF almost always had a worse performance compare to direct purchase of treasury bond…(So we are in a high risk low return scenario…right?)
I wonder if anyone has analyzed the new ETF RBIL which contrary to its name only holds TIPS that mature in less than 13 months. Seems to me that in an environment where we get a suppression of interest rates below the inflation rate this ETF could perform well (esp in a high inflation environment where longer duration TIP ETFs would perform poorly). Think VTIP but with no duration risk.
I haven’t look at this carefully, but if it is investing in TIPS with just 13 months remaining, it is taking on a LOT of unprotected principal (30% or more above par) which would be at risk if we get a lingering bout of deflation. It won’t be very diversified, holding just 5 TIPS at a time. I would guess it will do fine, but the deflation risk is worth considering.
Thank you David. Very good point. I would only consider RBIL in an environment where inflation is running hotter than current short term yields but when you think of an event like Covid TIPs got killed until the Fed and fiscal response eliminated the deflation risk. Definitely something to consider.
The issue for me re: Bonds is always the limit of $10K for me and $10k for my living trust per year. If there were unlimited amount of purchases I would buy IBonds, but I need inflation protection of more than $20K per year. To me, who is in the process of building my ladder, I need much more than $20K/yr so I no longer use them (I do have some high fixed rate IBonds from long ago but they are close to the 30 year mark).
This is a legitimate issue. To build a large stockpile of I Bonds, you need to buy every year. The gift-box method offers a solution, but only if you have a trusted partner. If you are building a ladder for a specific amount in future years, TIPS work very well for this and you can build the entire ladder in one day, ideally in a tax-deferred account.
Readers should take a look at Gene Ludwig’s (former head of the OCC) alternative inflation index, True Living Cost (TLC) on his web page vs the CPI. Also read about his method and logic.
If deflation actually occurs the TIPS bonds will still receive the coupon rate on the face value whereas the I-Bonds variable rate would go to zero?
In the highly unlikely case that we would have had deflation for 5 consecutive years, this particular TIPS would have returned 0.125% for the coupon rate or about 0.65% over the term, but the original investors paid a 7.5% premium over par and that would have been lost. Not good. The I Bond investor would have earned 0.0%, which would have been above the 5-year rate of deflation.
I’m quite certain the Gov wouldn’t allow multi years of deflation… they could go belly up pretty quick. Historically, inflation is probably needed to make the national debt of dollars manageable.
I meant to say devaluation of the dollar (inflation)… take your pick.
Sorry, but I simply cannot get my head around negative real returns (or interest rates). In effect, you are paying the government to borrow money from you. What am I missing here?
Bill (aka Hoyawildcat)
Bill, that TIPS ended up with a nominal annual return of 3.117% over five years. At the time, October 2020, 5-year CDs were paying about 0.85%. I guarantee we would have all jumped aboard joyously on any CD with a 3.1% nominal return in those days. It worked out.
Hindsight is always 20/20. I was referring to the initial decision to purchase a bond with a negative yield.
Bill, as I noted in my preview article back in 2020, there was a real potential for this TIPS to over-perform. And it did. So in foresight, I was right. (I was not a buyer.)
I’m also trying to wrap my head around negative real returns and why anyone would want such an investment. I believe that if held to maturity, neither TIPS or I Bonds will pay less than the face value principal, so no money would be paid to the government, but it would be possible to get $0 interest over 5 years.
Comparing a TIPS with a real yield of -1.32% to an I Bond at 0% fixed, leads me to conclude the I Bond is clearly the better choice, although either could return $0 interest in a 0% inflation scenario over 5 years. ANY positive inflation over that time would mean the I Bond would earn that rate of interest. For the TIPS to generate $0 interest I believe inflation would need to be 1.32% (or less) annually over the 5 years. Anything above 1.32% annually would generate interest for TIPS, but greater interest for the comparison I Bond.
If anyone sees anything wrong, please correct. And if there would be a reason to buy a -1.32% real yield TIPS instead of a 0% fixed rate I Bond, please explain (other than not wanting to deal with annual phantom taxes of the TIPS).
A negative real yield means at purchase, the purchase price is more than the bond value? If so, then you lose money unless inflation is enough to offset the negative real yield?
We definitely don’t want to go back to the days of negative real yields, which can never happen with an I Bond. I stopped investing in TIPS through that entire period but I still invested in I Bonds most of the time. I often called I Bonds a “screaming buy” versus a TIPS with a deeply negative real yield.
If the rate of inflation went to zero on the day you purchased this TIPS and stayed there until it matured, you would LOSS $68.05 per thousand you purchased. Figured like this.
You paid $1,074.30 for a face value of $1,000 at the auction. Since we stipulated no inflation the adjusted prin value would stay the same for the life of this TIPS, thus your annual interest payment would be constant at $1.25. When the bond matures you paid back $1,000. You only get paid back $1,006.25.
During this same hypothetical zero inflation period an I-bond with a zero fixed rate would have earned no interest. You would have paid $1,000 and gotten back $1,000.
In order to get back the entire $1,074.30 you paid for this bond at auction inflation must be at least 1.32% over the five-year period.
All I can say is: The lowest 5-year average inflation rate over the last 50 years was 1.4%, for the years ending in 2016 and 2017. But I agree that any TIPS with a deeply negative real yield isn’t appealing.
Whether a TIPS with a negative yield is appealing or not depends on your choices at the time. Ignoring the small amount you could have put in an I-bond, the choice at the time was between the nominal Treasury at 0.37% or a TIPS at -1.32%. One might think the Treasury is better but that is just an illusion. Why? Because you aren’t going to get 0.37% real on the Treasury. If one uses your lowest inflation for five years in the past of 1.4% then you would get -1.03% real on the nominal. If you use the Survey of Professional Forecaster’s estimate for inflation at the time of 2.03% (almost exactly the Feds target rate for inflation) you would get -1.70% real from the nominal. The Aruoba Term Structure of Inflation Expectations (ATSIX) forecast for inflation at the time was 2.15% resulting in a real yield for the nominal Treasury of -1.78%.
So, your choice was really between a TIPS with a guaranteed real return of -1.32% or a nominal Treasury with a real return of somewhere around -1.7% … or worse.
5-year CD’s were offering a real return around -1.6% … or worse with their nominal return of 0.42%.
In the fixed income world there really wasn’t any better option without taking on significantly more credit risk.
And the winner — by TKO — the I Bond!
I would love to see a post about the origin story of TIPS. I recently saw a 1980 Firing Line interview in which the guest – Ronald Reagan – discusses a Jack Kemp proposal to broadly index Treasuries to inflation. It makes one think why, today, we view nominals as the default/normal and TIPS as the exception/exotic; should we swap this? https://youtu.be/lTyZAul60ok?si=1LY1SNsGU4WVb5SP. 12-minute mark.
I think the reason why nominal Treasuries remain the default among big institutional players is because it is a huge market and therefore far more liquid and stable in times of sharp economic distress. For example, in March and April 2020 when the Covid shock hit, the economy seemed to be closing down, and suddenly deflation seemed more of worry than inflation, there was a huge sell-off of TIPS resulting in a sharp decline in price. Meanwhile investors were racing to the historical safety of nominal treasuries which went up in value. TIPS recovered when the Feds went on a bond buying spree including TIPS.
I asked my new, very bright friend, Chat GPT, about this time period. Part of the reply:
Using daily data from Bloomberg or FRED:
✅ Summary conclusion:
Yes — in March–April 2020, TIPS were far more volatile than nominal Treasuries of similar maturity due to liquidity stress, forced selling, and collapsing inflation expectations. Once the Fed stepped in, volatility and spreads normalized.
This seems intertwined with the “gold clauses” that many bonds had before the Great Depression, saying that the bondholder could demand payment in gold by the definition that existed when the bond was issued. The problem then was deflation and not inflation. Because the gold clause would thwart the government’s efforts to devalue the dollar to replace the money that had been destroyed in the collapse of the banking system, the government retroactively invalidated these clauses in both their own bonds and private contracts, and arguably the nominal bond was born?